The UK appears to have hit a rich seam of start-ups. From fintechs such as Monzo, Revolut and Starling to app-based services such as Deliveroo and the cyber security star Darktrace, there are a phalanx of quickly growing unicorns. The problem is that if these hot British start-ups do realise the potential their present rates of growth suggest is possible, the rewards will be immediately transferred out of the UK economy.
The most promising UK start-ups are largely funded by foreign capital. U.S.-based venture capital or private equity groups are major investors and China, the Asian financial centres and the Middle East are also rising in prominence.
That’s now being recognised as a problem. The U.S.A is the home of venture capital. That’s a statement borne out by statistics. In 2017, £63.7 billion was spent by venture capital companies closing investment deals in the U.S. In the UK the figure was £5.8 billion. Even adjusted for the size of the populations, the USA is home to 325.7 million in 2017 and the UK 66.02 million, the value of venture capital flowing into U.S. start-ups is approaching 3 times that going into UK peers. And as already mentioned, most of the VC cash going into the UK’s best start-ups isn’t even coming from domestic investors.
While it may be too simplistic to provide a full explanation, there is an obvious argument that the reason the UK hasn’t produced a Google, Facebook, Amazon or even Netflix or Tesla because our companies don’t have access to the level of funding required to fuel that level of growth. And one of the solutions being put forward as part of the solution is to find ways to channel some of the £2.4 trillion locked up in the UK’s pension assets.
U.S. venture capital firms are largely funded by pension and insurance companies. A huge 98% of their funds are derived from that source. Some of the bigger funds, such as the California Public Employees’ Retirement System, even invest in start-ups and smaller growth companies directly. That’s not been lost on figures within the UK government who are actively looking at ways to encourage some of the huge sums of money tied up in UK pensions and insurance funds into venture capital.
A large part of the problem is the more conservative nature of UK pension funds which are hesitant to take on the level of risk that investing in young companies represents. There are some that do have funds that focus on investing in small companies, like Legal & General. Others run funds with an allocation to smaller, private companies. But it’s a minority and policy makers believe pension fund managers need to be nudged into cultural shift to open the gates and see cash flow towards UK start-ups and smaller companies with high growth potential.
Defined contributions pensions, forecast to be managing over £1 trillion in assets by 2025 are a target. A feasibility study is currently being put together by the state-owned British Business Bank in partnership with six major providers of defined contribution pension schemes. Its goal is to better understand the barriers that are preventing UK funds from channelling money towards the country’s start-ups and what solutions might be available. One idea is to come up with a structure that will pool funds from pension providers, spreading risk but still unleashing a torrent of cash into the sector.
The size of the opportunity is considered to be huge. Now what remains to be done is to ensure UK start-ups have access to the cash they need to fund rapid and major growth. And for that cash to originate in the UK so the UK benefits from the fruits of investment.